ESG-linked loans: A game changer for the future of corporate sustainability?

SHARE

Sustainability is not only wise for the earth, but a must for most businesses: 97 percent of surveyed CEOs list it as “key” to their business success.[1]Companies that manage sustainability risks and opportunities tend to have stronger cash flows, lower borrowing costs and higher valuations over time.[2]

Investors agree that sustainable investment is simply smart investment. In a recent study, Sustainable investing: a ‘why not’ moment, BlackRock Investment Institute shows how sustainable portfolios that consider environmental, social and governance (ESG) factors may outperform in the long run as flows into sustainable investment products increase and climate risks compound.[3]

Sustainable lending to incentivize positive change

New financial products are emerging in response to a growing appetite for sustainable lending in the corporate and finance communities. One of these products links loan pricing to a company’s ESG performance, offering a discount when a company outperforms its sustainable goals or even a premium when they underperform.[4]Unlike green bonds and green loans that are based on the voluntary guidelines of Green Bond Principles and Green Loan Principles, respectively, there is no standard definition for sustainability-linked loans. These loans do not require earmarking proceeds for dedicated use; they only need to report performance according to ESG criteria usually verified by an independent third party.[5]

For companies, ESG-linked loans offer access to preferential interest rates based on sustainability improvements, leverage capital incentives for meaningful sustainability impact, and demonstrate to stakeholders a commitment to sustainability. For lenders, ESG-linked loans help them as sustainable finance leaders, which enhances their value proposition to their customer base, sharpens their competitive differentiation,[6] and reduces loan default rates.[7]These loans have the potential to bolster not only environmental and social sustainability, but also financial success for both investors and businesses.

Demand for ESG-linked loans is growing

The first example of ESG-linked loans was led by the global finance institution, ING, and Phillips, the Dutch health technology company, on a $1.2 billion syndicated loan agreed with a consortium of 16 banks in April 2017. The interest rates were linked to an ESG rating assessed by an independent third-party ratings agency, Sustainalytics[8].

More companies are following this lending trend, specifically those in the food and agricultural sector. In November 2017, the Asian agribusiness Wilmar International and ING converted a portion of their bilateral Revolving Credit Facility valued at $150 million into a sustainability performance-linked loan, the first of its kind for companies in Asia. [9]Danone, the French food products company, introduced ESG criteria to its syndicated $2.3 billion facility led by BNP Paribas in February 2018. The interest rate was linked to two goals: performance against ESG criteria, and percentage of consolidated sales of Danone covered by Benefit-Corporation certifications. Third-party rating agencies, Sustainalytics and Vigeo Eiris, assessed their performance.[10]In March 2018, agribusiness Olam International announced Asia’s first sustainability-linked club loan with 16 banks, a revolving $500 million credit facility. Its performance will be assessed annually, also by Sustainalytics.[11]

This innovation led by international players has sparked interest from Asian regional banks. In June 2018, OCBC Bank, a local Singapore lender, committed to a sustainability-linked bilateral loan with $200 million revolving credit facility.[12]

A bright financial future for sustainability?

It is still the early days for ESG-linked loans. The ability to incentivize stakeholders and address sustainability improvements in areas where they are most needed remains to be proven. The win-win-win scenario for business, investor and larger society emerging from ESG-linked loans is nevertheless compelling; momentum is building. Since ING’s first ESG-affiliated loan in 2017, more than 15 similar loans have been created.[13]More work is needed to develop common standards for meaningful disclosure of impact; however, ESG-linked loans represent a crucial step in the right direction – leveraging today’s financial landscape that rewards businesses committed to building a more sustainable future.

USAID Green Invest Asia engages with companies and investors on sustainability issues in agriculture and forestry in Southeast Asia, and support ESG integration for investors. To learn more about us, please visit www.greeninvestasia.com or write info@greeninvestasia.com.